If you invested in February chances are your investment took a 34% dive. The same investment in March could see an increase of 25%. If the same investment was made in April your investment could increase by around 7%. And May may not be over, but your investment would not have increased much by May 20th. Suffice to say the stock market is volatile.
Despite how the market feels, we have not entered a recession yet, at least not by the definition of losing 40% of value. However, with many hits to the economy it is at least possible we can see a stock market recession soon. Because of this many people are afraid of investing because a recession may be neigh. However, there is a good strategy for investing during a recession that will maximize the chance of returns. It allows you to take advantage of growths in the market while allowing you to buy during sales, all while managing volatility. Using this strategy is like going into battle with a sword and shield, you can play offensively and defensively simultaneously and with little change in your strategy.
Dollar Cost Averaging
Let’s say someone gave you three thousand dollars and you wanted to invest that money, how would you invest it? All at once? That would be lump sum investing. But let’s say you invested all of that money on February 19th, 2020 right at the height of the stock market, you would be out of about $1,000 by the low in March. If you invested during the low in March (March 23rd, 2020), you would have made just over $600. If you invested at the end of April to the beginning of May, congrats on the extra few bucks you made.
Let’s say you divide the investments for each of the three months since the start of the crash. The first $1,000 would be invested during the high. You would have lost about $319.31 from February to March 20th. The second $1,000 would have been invested around the low in March. That would be around $1,680.69. Then to April 20th the amount would increase to $2,058.58. The portfolio would have next to no gain then. Invest the other $1,000 during that time and the market would increase by May 20th. The portfolio would be $3,219.41.
That would be about a 7% return. Because the investments were made as regular payments the risk was mediated. Even during one of the most volatile times in the stock market you would have had a decent return. Keep in mind, the calculations I made assume one of the investments were made during the high so this arguably is a bad case scenario calculation. You would have more returns if you did not invest during the highest point and invested during the lowest point.
Dollar cost averaging is a method for investing during recessions to mediate risk during volatile times. You may not have as much of a return as if you timed the market perfectly, but you will never be able to pull that off perfectly.
Problems With Dollar Cost Averaging
Although dollar cost averaging is a good method for investing during a recession, I would hardly call it a strategy. Just maintaining the course for your investment is not much of a strategy as it does not have much tactical considerations. Lump sum is even less of a strategy, it relies too much on luck.
I use an adjustable dollar cost averaging strategy. Like dollar cost averaging I make regular investments, but unlike dollar cost averaging I do change the amount depending on the month and schedule. In simplistic terms, I lower the amount I contribute when the markets do well and increase them when they do not.
There are two ways to do this. One is by controlling your retirement account closely by changing contributions each interval. Set up a contribution rate that you would be comfortable with, but that you could also increase to twice as much or half as much without making you a sweat.
The second way is the one I use. I have a 401k and a Roth IRA. My regular contributions go into my 401k and I very rarely change it. If the markets go lower, I contribute more to my Roth IRA while keeping the contribution rate of my 401k.
Let’s say you invest the $1,000 during the height. You will still face the loss, but then you decide that the market went down and it is a good sale, you increase your contribution. However, you decide not to double it because then you have nothing to contribute in April, so you increase your contribution to $1,500. Then because the market rallied you feel comfortable contributing a smaller $500 in April. So by March, you will have a portfolio that is $2,180.69 instead of $1,680.69 if you just used dollar cost averaging. By April the stock market will increase and the portfolio will be $2,671.00. With the final contribution of $500 and the gain in the stock market to May 20th would make the portfolio valued at $3,337.74. That would be a return of over 11%.
Key To Adjustable Dollar Cost Averaging
The adjustable dollar cost averaging strategy only works if you have extra money to spare. You do not want to use this investing strategy during a recession without the wiggle room for money. Your contributions are only as adjustable as you are. If you can only contribute 3% of your earnings to the stock market because the other 97% is for your lifestyle, you cannot increase your contributions, only lower them. You should have a lifestyle that is fairly well below the means of your earnings for this to work.
Dollar cost averaging is one of the best methods to ride the storm that is an economic recession. It is much like having a sword and shield during a battle. You have the capabilities to take on the markets defensively when markets go up and offensively when markets go down. And the method is easy to set up. You can set up automatic contributions with little more than a click of a button. However, you can change your contributions using the adjustable dollar cost averaging method as a strategy to invest during a recession.